Is Owner Financing Residential Real Estate Safe?
By: R. Scott Alagood
Owner financing in Texas has historically been a valued tool to sell real estate to parties who for various reasons couldn’t qualify to borrow money from institutional lenders. However, in 2008 and 2009, owner financing was directly affected by federal law to adopt Chapter 180 of the Texas Finance Code, now better known as the Texas SAFE Act. The acronym “SAFE” stems from the Secure and Fair Enforcement for Mortgage Licensing Act, which was part of the federal Wall Street Reform Act of 2008. These Acts were spurred by the belief that the liquidity crisis in the financial markets was caused in part by mortgage fraud and subprime mortgage loans.
One of the objectives of the federal SAFE Act was to provide uniform requirements for state licensed loan originators, or what we in Texas formerly referred to as mortgage brokers. The Texas SAFE Act renamed the mortgage broker as a “residential mortgage loan originator” or “RMLO” and broadened the State licensing requirements necessary to perform certain functions associated with the issuance of a residential mortgage loan. This is where the problem arose for owner financed transactions.
The Texas SAFE Act, defines a RMLO as any individual who for compensation or gain, or the expectaton thereof, either takes a residential mortgage loan application or offers or negotiations the terms of a residential mortgage. Certain exclusions and exemptions from licensing are provided in the statute, including licensed real estate brokers and salespersons, licensed manufactured housing brokers, no interest/fee loans, loans to an immediate family member and loans involving the sale of the owner’s homestead. Even licensed attorneys may be subject to further licensure where the negotiation of a mortgage loan is not an ancillary matter to the attorney’s representation or the attorney takes an application and offers or negotiates the mortgage terms. Any owner financing transaction which does not otherwise fall under one of the exempted categories will clearly meet the definition of an RMLO and require licensure by the party offering or negotiating the mortgage loan.
The Texas agency responsible for enforcing the SAFE Act is the Texas Department of Savings and Mortgage Lending. Violations of the SAFE Act include license suspension, a fine of up to $25,000.00, a restitution to the buyer. At this point, it is unclear what “restitution” means.
Fortunately, the commissioner of the Department of Savings and Mortgage Lending issued a notice in August of 2010, setting forth a seller financing “de minimus” exception to the Texas SAFE Act. Before the federal and Texas SAFE Acts, Section 156.202(a)(3) of the Texas Finance Code exempted from licensing “an owner of real property who in any 12 consecutive month period makes not more than five mortgage loans to purchasers of property for all or part of the purchase price of the real estate against which the mortgage is secured.
The commissioner pointed out that adopting Chapter 180 of the Texas Finance Code, the legislature had amended Section 156.202, but left Section 156.202(a)(3) intact. Since the amendments to Section 156.202 were passed after Chapter 180, the commissioner determined that the legislature intended that the de minimus exception remain. Unless there is a subsequent statutory amendment or rule, or the U.S. Department of Housing and Urban Development issues a conflicting ruling, the Commissioner has stated that the de minimus exception will continue to be allowed by the Department of Savings and Mortgage Lending.
In considering whether or not a transaction falls within the de minimus exception, the 12 month period is a rolling period, and not determined on a basis of a calendar year. Also, for business organizations, the term “owner” will in all probability be viewed at the ultimate ownership or control level. This means that a person will not be allowed to transfer ownership into separate business entitites (i.e. corporation, partnership, LP, LLC, etc) for purposes of eluding the five transaction limit in any 12 month period.
Clearly financing the sale of your own property is more tricky than it used to be. For situations where a transaction clearly falls within the licensing requirements of the SAFE Act, you are advised to seek the services of a licensed RMLO and/or an experienced attorney. With some careful planning and consideration of the transaction, the regulatory pitfalls of the SAFE Act may be avoided.
Scott Alagood is Board Certified by the Texas Board of Legal Specialization in both Commercial and Residential Real Estate Law.